Should We Worry About Rising U.S. Corporate Debt?

Should investors be troubled by an under-the-radar statistic on corporate debt? A recent report by S&P Global found that the debt load for U.S. corporations has reached a record $6.3 trillion. That’s higher than it was in 2007, and we all know where that ended.

Admittedly, U.S. companies also have chunky cash reserves with which to service this debt, but that tends to be in hands of a few giant companies. The research looked at the cash balances at the end of 2017 for non-financial corporations.

Speculative-grade borrowers had a cash-to-debt ratio of just 12% in 2017. That is equivalent to $8 of debt for every $1 of cash and below the 14% reported in 2008 during the crisis. This seems like it should be a problem in a climate of rising rates, particularly for U.S. corporate bond investors. At the very least, the need to refinance debt at higher levels is likely to act as a drag on corporate earnings, but could it prompt another crisis?

Ed Smith, head of asset allocation research at Rathbones, believes these higher debt levels could mean big employers in the US may need to cut back on personnel as interest rates shift, with a knock-on effect for employment levels and U.S. economic growth.

However, Erin Browne, head of asset allocation UBS Asset Management, says the problem may not as bad as it appears: “Debt in the U.S. corporate sector is at an all-time high. It is at about the same level as was seen in the previous two recessions – 2001 and 2008. However, when is this a real concern? Net leverage has not risen nearly as high and is, in fact, near its 30-year average. Interest cover is also pretty solid.”

The debt is relatively short term in nature. Corporates have been more responsible in the way they've borrowed and have a manageable maturity schedule, she argues. Interest cover is relatively healthy and, while there are potential dangers, in her view, there is no imminent crisis.

Are there other areas of concern?

China’s corporates have been seen as another major area of worry. Debt in Chinese state-owned entities (such as banks) debt stands at 115% of GDP. The defense is usually that China is a huge creditor nation, so the corporate sector is a little like the errant son of a wealthy parent. It may not be sending the right messages, but he’s probably going to get bailed out in the end. Smith points out that the pace at which debt is being accumulated has been falling for a number of years. As such, he sees China as much less of a risk.

Government debt numbers are eye-watering and could also be seen as another major area of concern: governments currently have debt of $63 trillion. The U.S. has the highest absolute debt burden, with around a third (31.8%) of the total; Japan also has a chunk (18.8%) and China the next largest piece (7.9%).

Of these countries, the most immediately worrying is Japan, where its debt amounts to 239% of GDP, sustained by a lacklustre economy. However, the U.S. debt burden is about to get significantly higher as Donald Trump’s tax cuts come into effect. The Congressional Budget Office said the U.S. budget deficit will surpass $1 trillion by 2020. However, this is only likely to become a systemic problem if people refused to fund it. David Jane, multi-asset manager at Miton, believes that if Japan can find buyers for its debt, the U.S. will be able to as well.

Systemic risks?

With this in mind, although there are pockets of high debt in the global economy, there don’t appear to be any systemic problems. Jane points out that there is unlikely to be a second debt crisis so soon after the debt-driven Global Financial Crisis: “The thing that policymakers worry most about is the least likely to occur. It used to be inflation, now it is debt.” That doesn’t mean people can’t lose money in government or corporate bond markets or that higher repayment levels won’t bring forward the next recession, but the financial system itself does not appear to be vulnerable.

Jane believes that the real issue is what happens to the price of debt securities. There has been a lot of anomalous pricing that needs to be resolved. Debt will be repriced and that could see certain parts of the bond market lose money for a prolonged period. Fixed income markets have seen a lengthy bull market, but the future may be more difficult.

Starting an investment journalism career at the height of the technology boom may have been a baptism of fire, but it taught me some important lessons about financial markets. I’ve been writing about companies, stock markets and economies ever since, building a career on tr...